Real estate in India: How real is the hype?

According to reports by Cushman and Wakefield, there has been a 15 per cent drop in the valuation of private equity deals in the first nine months of 2012.

BankBazaar.com | Last Updated: March 25, 2013 12:26 (IST)

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Metropolitan cities in India are fast becoming a hub of industrial parks, high rises, residential complexes, sprawling malls and huge commercial complexes, which are gradually but steadily transforming their skyline. If you are commuting on the busy and packed streets of Delhi, Mumbai, Bangalore, Hyderabad, Kolkata or any other tier I city, you will come across brightly colored cranes, rubble, construction and hordes of workers scurrying up and down the towering skyscrapers. This surely urges you to contemplate on the explosion of real estate sector in India.

Is it a mirage? How real is the influx of investments by speculative and long-term profit makers? Are the commitments by oversized private equity firms, overseas investors and domestic financial institutions adding to the hype and frenzy created in the concrete world of real estate?

Astute watchers in the property sector feel that the bubble is not as big as it seems. According to prominent investors, brokerage firms and property developers, there are certain factors which are failing to add the right tempering to the real estate markets in India.

It is quite evident that the funds brought in by the foreign investors are only a small percentage of the promised amounts.

Price resistance from real estate purchasers and the soaring prices of land are cutting deeply into the investor's margins, making real estate ventures less lucrative than expected.

Bureaucratic lethargy coupled with red tape, opaqueness in regulations and the absence of insurance title prove to be other concerns for real estate investors.

Investor sentiments According to reports by Cushman and Wakefield, there has been a 15 per cent drop in the valuation of private equity deals in the first nine months of 2012. Their observations are based on the following:

Investors are putting their money in residential deals rather than commercial ones.

PE players are showing an increasing preference towards the metros rather than class II cities in the hope of better liquidity and higher returns.

The investments are being made on the basis of the assumption that real estate prices will not change in the near future.

Investors are looking towards projects which have all approvals and licences in place and are expected to have short cycles. The assurance of quick and stable returns is guiding their purchase and investment decisions.

They are also having a greater say in the prices of projects. This is decreasing the scope for automatic price correction or defining of prices by the developers.

Current scenario The current situation is raising fears of an overheated economy and real estate bubble. This has inspired the central banks to initiate a lender cutback on the amounts sanctioned for real estate loans. The act has caused an upward escalation in the rates of interest and lowered the attractiveness of home financing for consumers. As a result, the cost of home and office rentals along with their purchase price has ended up touching unprecedented heights.

So where does this scenario leave the investors and property purchasers?

A majority of Indian real estate companies are privately held and do not disclose their financial health to investors and buyers. The inability to read the right signals in the absence of readily available information on products such as retail outlets, industrial property, residential apartments and offices is causing grave concerns in the minds of the investors.

Rumors related to the misfiring of a large deal or reports of distress sales by prominent property developers is further adding to the confusion in investor sentiments.

The prices of property in the Indian markets are being stoked by the following factors:

Numerous speculative deals taking place in the hope of making faster and better gains

The rising cost of construction with respect to raw material, labor and other costs

An unexpected hike in the excise prices

Increase in service tax rates

The escalation in land prices

The present scenario in the Indian real estate markets is raising concerns with regard to future profit margins for foreign investors. Contrary to the figures in the past two years, when increasing valuation in property yielded returns as high as 30-40% on investments, the expected returns in the days to come are not expected to go higher than 15-20%.

Foreign investors are now looking towards other emerging markets such as those of Latin America and Eastern Europe.

Future trends According to analysts, this is a good time for purchasing real estate intended for long-term investment and end use. The cyclical nature of the markets is expected to push up the residential property rates in the next three years. If the investment horizon is greater than this period then it makes good business sense to invest in property in metros and other fast developing cities.

The decision to purchase property in the emerging areas should be backed by a complete analysis of the demand-supply forecasts and infrastructure plans for the region. As far as capital appreciation and rental yields are concerned, mid-range houses are expected to provide better returns than luxury apartments or premium property purchased at discounted prices.